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Analysis of the cost of infrastructure failures in a developing economy: The case Analysis of the cost of
infrastructure failures in a
developing economy: The case
of the electricity sector in Nigeria
By
Adeola Adenikinju
Department of Economics
and
Centre for Economics and Allied Research
Univeristy of Ibadan
Ibadan, Nigeria
AERC Research Paper 148
African Economic Research Consortium, Nairobi
February 2005 ©
2005, African Economic Research Consortium.
Published by:
The African Economic Research Consortium
P.O. Box 62882-00200
Nairobi, Kenya
Printed by:
The Regal Press Kenya, Ltd.
P.O. Box 46166-00100
Nairobi, Kenya
ISBN 9966-944-59-1 Table of contents
List of tables
Acknowledgements
Abstract
1.
Introduction
1
2.
Problem statement
3
3.
Objectives of the study
5
4.
Review of the literature on electricity outages
6
5.
Structure of the electricity market in Nigeria
11
6.
Survey methodology and models
15
7.
Analysis of survey findings
19
8.
Measuring the cost of power outage
25
9.
Analysis of regression results
28 List of tables
1.
A typology of selected previous studies
7
2.
Estimated outage costs in selected previous studies (US$ per kWh)
8
3.
NEPA energy output, 1997
13
4.
Distribution of target and realized sample by location and size of
establishments
15
5.
Distribution of respondents by sector, scale of operations and location
19
6.
Data description
20
7.
Ranking of severity of infrastructure problem in Nigeria (per cent)
21
8.
Percentage of respondents ranking electricity as most important or
second most important infrastructure in Nigeria, by sector (per cent)
21
9.
Sources of electricity used in the manufacturing sector
21
10.
Mean cost structure for auto generation for Nigerian manufacturers
22
11.
Proportion of total investment at start up devoted to provision of
own electricity facilities by firm size
22
12.
Respondents perception of the frequency of power outages per week
23
13.
Respondents perception of the average duration of outages
23
14.
Electricity consumption and average cost
23
15.
Firms perceptions of the factors responsible for the poor
performance of NEPA
24
16.
Firms perceptions of how to improve NEPA
24
17.
Marginal cost of generator or the willingness to pay for reliable
electricity (in naira per kilowatt-hour)
25
18.
Distribution of outage costs (N000)
26
19.
Decomposition of losses by type
27
20.
Proportion of total output loss due to power failure in 1998
27
21.
Mitigated and unmitigated losses (N000)
27
22.
Determinants of outage costs
28
23.
Determinants of outage costs, including sector, location and scale
29
24.
Impact of outage costs on output performance
30 Acknowledgements
I wish to express my deep appreciation to AERC for the financial support to carry out
this research. I am also grateful to the resource persons and members of AERCs Group
AT for various comments and suggestions that have helped the evolution of this study
from its very beginning to this stage. Two anonymous referees who reviewed the paper
provided perceptive comments that have been quite useful in improving the overall quality
of the paper. I am, however, responsible for all the remaining errors. Abstract
Infrastructure has been identified as the key constraint to private sector development in
Nigeria. Hence, this study analysed the cost of power outages to the business sector of
the Nigerian economy using both a survey technique and revealed preference approach.
One strong outcome of the study is that the poor state of electricity supply in Nigeria has
imposed significant costs on the business sector. The bulk of these costs relate to the
firms acquisition of very expensive backup capacity to cushion them against the even
larger losses arising from frequent and long power fluctuations. Small-scale operators
are more heavily affected by the infrastructure failures as they are unable to finance the
cost of backup power necessary to mitigate the impact of frequent outages. The small-
scale operators that could afford to back up their operations have to spend a significant
proportion of their investment outlay on this. The study advocates for institutional reforms
of the power supply sector in Nigeria. A
NALYSIS

OF

THE
C
OST

OF
I
NFRASTRUCTURE
F
AILURES

IN

A
D
EVELOPING
E
CONOMY
1
1
1. Introduction
I
t is fairly settled in the literature that infrastructure plays a critical and positive role
in economic development. Infrastructure interacts with the economy through multiple
and complex processes. It represents an intermediate input to production, and thus
changes in infrastructure quality and quantity affect the profitability of production, and
invariably the levels of income, output and employment. Moreover, infrastructure services
raise the productivity of other factors of production (Kessides, 1993).
The provision of infrastructure in most developing countries is the responsibility of
the government. This is because of the characteristics of infrastructure investment. First,
infrastructure supply is characterized by high set-up cost. Its lumpiness and indivisibility
precludes the private sector from investment. Second, its indirect way of pay-off, coupled
with its long gestation period, makes it generally unattractive to private investors.
Moreover, provision also generates externalities that the producer may not be fully able
to internalize in the pricing structure. Thus, in the face of other numerous competing,
less risky and more familiar investment opportunities offering the promise of higher and
quicker returns, few private investors are willing to embark on infrastructure investment
(Ajayi, 1995).
However, the nearly exclusive concentration of infrastructure provision in the hands
of the public sector, especially in developing countries, has led to failures in the supply
of these services. Faced with declining economic fortunes and dwindling revenue, most
governments in developing countries found it increasingly difficult to keep pace with
adequate provision and maintenance of infrastructure. Moreover, the perception of
government that economic infrastructure is a social service affected the pricing of its
products and consequently the effectiveness of their provision. Besides these, the
traditional inefficiency associated with public monopolies affects the quality and reliability
of their services.
There are five main approaches used in the literature to infer the welfare losses from
power outages. These are the production function approach, self-assessment analysis,
economic welfare analysis, contingent valuation and, finally, the revealed preference
approach. These methods have their relative strengths and weaknesses. They have been
used widely in both developed and developing countries, especially the former, to infer
outage costs. For the industrial sector, existing measure of outage costs vary between
$1.27 to $22.46/kWh of unserved electricity. Residential outage costs vary between $0.02
and $14.61/kWh unserved (Caves, Herriges and Windle, 1992).
The rest of this study is organized as follows: Section 2 presents the problem statement,
while Section 3 highlights the objectives of the study. Section 4 contains the literature 2
R
ESEARCH
P
APER
148
review, Section 5 presents a review of the electricity sector in Nigeria and Section 6
contains the analytical framework for the study. The survey methodology and empirical
models are presented in Section 7, followed by the analysis of survey findings in Sections
8 and 9, which contain the measurement and analysis of outage costs and regression
results, respectively. The final section presents the policy implications and conclusions. A
NALYSIS

OF

THE
C
OST

OF
I
NFRASTRUCTURE
F
AILURES

IN

A
D
EVELOPING
E
CONOMY
3
2. Problem statement
I
n Nigeria, poor electricity supply is perhaps the greatest infrastructure problem
confronting the business sector. The typical Nigerian firm experiences power failure
or voltage fluctuations about seven times per week, each lasting for about two hours,
without the benefit of prior warning. This imposes a huge cost on the firm arising from
idle workers, spoiled materials, lost output, damaged equipment and restart costs. The